Ch 4 part 1 Flashcards
When a corporation makes a nonliquidating distribution to a shareholder, what 2 questions must the corporation answer?
1 what are the amount and character of the gain or loss the
Corporation must recognize?
2 what effect does the distribution have on distributing the
Corporation’s earnings and profits?
When a corporation makes a nonliquidating distribution to a shareholder, what 3 questions must the shareholder answer?
1 what is the amount of the distribution?
2 to what extent is this amount treated as a dividend
3 what is the basis of the distributed property and when does
It’s holding period begin?
Section 301 requires the shareholder to include in gross income…
The amount of any corporate distribution to extent it is treated
As a dividend
Dividend
Distribution of property made by corporation out of earnings And profits (E&P)
How does section 317a define property?
Includes money, securities and other property
Except stock or stock rights of distributing corporation
Distributed amounts that exceed a corporation’s E&P are treated as…
Return of capital that reduces shareholder’s basis in his stock
(But not below 0)
Distributions exceeding the shareholder’s basis are treated as…
Gain from sale of stock
2 kinds of corporate E&Ps
1 current E&P
2 accumulated E&P
Current E&P
Calculated annually
What does E&P measure?
Corporation’s economic ability to pay dividends to its shareholders
Accumulated E&P equation
Accumulated E&P =
(Sum undistributed current E&P for all previous years balances)
- (sum of all previous current E&P deficits + distributions made out
Of accumulated E&P)
Distributions are deemed to be made out of E&P accounts in which order?
First out of current E&P
2nd out of accumulated E&P
Computation of current E&P
Taxable income
+ income excluded from taxable income but included in E&P
+ income deferred to later year but included in E&P
+/- income and deduction computed for E&P
+ deductions allowed for taxable income purposes/denied for E&P
- expenses and losses denied for taxable income/allowed for E&P
= current E&P balance (or deficit)
Income excluded from taxable income but included in E&P 4
1 tax exempt interest
2 proceeds from life insurance where corp. is beneficiary
3 recoveries from bad debts where corp received no tax benefit
4 prior yr. Federal tax refunds
Income and deduction items that must be recomputed for E&P purposes 3
1 income for long term percentage completion contracts
(Instead of completed contract method)
2 depreciation on personal and real property
3 excess percentage depletion over cost depletion
3 deductions that are allowed for taxable income but denied for E&P
1 dividends received deduction
2 NOL carryovers, charitable carryovers, capital loss carryovers
Applied to current year
3 US production activities deduction
Expenses and losses that are denied for taxable income purposes but allowed for E&P 8
1 federal income tax
2 premiums on life insurance (corp is beneficiary)
3 excess capital losses not currently deductible
4 excess charitable contributions not currently deductible
5 expenses related to production of tax exempt income
6 no deductible losses on sales to related parties
7 no deductible penalties and fines
8 non deductible political contributions and lobbying expenses
Income excluded from taxable income but included in E&P: Current E&P includes the recovery of an item deducted in a previous year if…
The deduction produced no tax benefit for corporation and
Was therefore excluded from its taxable income
Income deferred to later year when computing taxable income
but included in E&P in current year
Gains and losses on property transactions generally included
in E&P is same year they’re recognized for taxable income purposes
With installment sales, entire realized gain must be included
In current E&P in year of sale
Income and deduction items that must be recomputed for E&P: depreciation
Must be recomputed under the alternative depreciation system
Sec. 168g
E&P: federal income taxes
Subtracted from taxable income
Charitable contributions
Current years deduction is subtracted from taxable income
The carryover is added to taxable income and deducted
In later years
Taxation: if current E&P is sufficient to cover all distributions during the year, how is the distribution treated?
2) when does this rule continue to apply?
Treated as taxable dividend
2) rule still applies if deficit exists in beginning accumulated E&P
Account
If corporation generates both a current E&P deficit and an accumulated E&P deficit, how are the distributions treated?
Distributions are treated as return of capital to extent of
Shareholder’s stock basis, distributions exceeding basis are
Taxed as capital gain
Non of the distributions are treated as a dividend
If a corporation has both an accumulated E&P deficit of $20k and a current E&P deficit of $15k and the corporation distributes $10k, what is the accumulated E&P deficit for the following year?
$35,000, the distribution was not made out of E&P
How are gains/losses recognized on distribution from corporation to shareholders of land or inventory?
The corporation must recognize the gain but not the loss on the
Distribution
When a corporation distributes property to a shareholder, the distribution amount is?
How will the amount of any liability distributed to the shareholder affect the distribution amount?
The property’s FMV on the date of distribution
Liability assumed by the shareholder reduces the distribution
Amount but never below $0
What is the shareholder’s basis when he receives a property distribution from the corporation ?
When does the holding period begin for the shareholder?
FMV basis
Holding period begins the day after the distribution (doesn’t
include the corp’s holding period)
When a corporation distributes property and liabilities to a shareholder, how do the liabilities affect the shareholder’s income and adjusted basis?
Liabilities reduce the shareholder’s income
Liabilities don’t affect the shareholder’s adjusted basis in
The distributed property
When a corporation distributes appreciated property to its shareholder’s it must increase E&P…
By the E&P gain
E&P gain calculation
E&P gain = property’s FMV - E&P adjusted basis
When a corporation distributes its own obligations (notes, bonds) to the shareholder, E&P is reduced by…
The principal amount, not the FMV
If E&P adjusted basis of non cash asset distributed equals or exceeds FMV…
2) if the FMV of the asset distributed exceeds its E&P adjusted basis…
E&P is reduced by asset’s E&P adjusted basis
2) E&P is reduced by asset’s FMV
Constructive dividend
How IRS/courts might recharacterize an excessive corporate
Payment
How does the IRS treat the constructive dividends
Recast as E&P distribution
Deny corporation offsetting deduction, treat all or portion
Recognized by shareholder as a dividend
Without recharacterization, a loan would be… 2 things
1 neither deductible to the corporation
2 nor taxable to the shareholder
Loans to shareholders may be viewed as disguised dividends unless…
The shareholder can prove the loans are bonafide
Shown by their intent at the time they take the loan, and repay
It
If shareholder purchases corporate property at a discount from the property’s FMV?
The discount may be treated as a constructive dividend to
The shareholder
Distribution of Stock dividends
Usually not taxable
Taxable when the shareholder’s proportionate interest in the distributing corporation changes
Taxable stock dividend distributions include 4 instances
1 when shareholder can elect to receive stock or other property
2 some shareholders receive property, others receive an
Increase in proportionate interest of corporation
3 some holders receive preferred stock, others receive common
4 distribution includes preferred and convertible preferred
Distribution of Stock rights
Nontaxable unless it changes or has the potential to change the
Shareholders’ proportionate interest in the distributing corporation
Receiving stock rights less than 15% value of the stock the share holder owns
2) receive 15% or more stock rights of value of stock shareholder owns
The stock rights will have a basis of $0, unless the shareholder
Elects to allocate his stock basis between the stock and stock
Rights
2) if 15% or more, it’s mandatory to allocate the basis between
The stock and stock rights
If the stock rights expire
The shareholder can’t claim a loss
The basis of allocated rights is added back to the basis of
Stock
If the taxpayer exercises the stock rights before they expire, what happens to the taxpayer’s basis? Holding period?
The basis of allocated rights is added to the basis of stock
Acquired through exercise of the rights
Holding period for stock acquired begins on exercise date
If distribution of stock or stock rights is taxable, what is the distribution amount equal to? How is it treated?
Distribution amount equals the FMV of stock or stock rights
Distribution is treated like a dividend
Stock redemption
Corporation’s acquiring its own stock in exchange for corporate
Property
Corporate property
May be cash, securities of other corporations or any consideration
The corporation uses to acquire its own stock
What 3 actions might the corporation take with reacquired stock?
1 cancel the acquired stock
2 retire it
3 hold it as treasury stock
A redemption may be treated in 2 ways depending on the situation
1 redemption resembles a dividend
2 redemption resembles a stock sale
When does a redemption resemble a dividend
2) when does the redemption resemble a capital gain sale
When the shareholder’s proportionate ownership hasn’t changed
Because of the redemption
2) when there is a change in the proportion of ownership interest
5 conditions for stock redemptions to be treated as sales, when redemptions are:
1 substantially disproportionate
2 complete termination of shareholders interest
3 not essentially equivalent to a dividend
4 involves partial liquidation of corp. in conjunction with its
Redeeming stock from non corporate shareholder
5 provides funds for an estate to pay death taxes
How is a stock redemption taxable as a sale compared to a dividend .
Sale: FMV - adjusted basis is taxable
Dividend: whole FMV is taxable, the taxpayer’ basis is surrendered
And added to remaining shares still owned
2 advantages of structuring stock redemption as a sale
1 capital gains may offset capital losses
2 basis of shares redeemed reduces amount of income recognized
Tax consequences of distributing corporations: stock redemptions
1 corporation recognizes a gain immediately after transaction,
But not a loss
2 E&P adjustment
Corporate E&P adjustments 3
1 E&P reduced by redemption treated as dividend
2 E&P reduced by portion of current and ACC. E&P attributable
To redeemed stock in sale
3 any distribution exceeding E&P reduces corporation’s paid-
In capital
Stock redemption in which ownership interest remains the same or increases is treated as a dividend, unless…
The corporation doesn’t have sufficient E&P
Stock redemption: attribution rules
Test if stock redemption should be treated as a dividend or sale
